Additional paid-in capital (APIC) or capital surplus is the money investors pay above the par value of shares. The premium paid above the face values of the newly issued shares is called the share premium or additional paid-in capital.
It is received by a company when it issues common or preferred shares. It can only be received at the time of IPO, direct listing, or rights issue. It can be eliminated or reduced by retiring stocks permanently.
What is Additional Paid-in Capital?
Stocks are issued at a low nominal value to avoid any legal complications by companies. The par value is often set at $1.0 or even a fraction of a dollar. However, on IPO day the investors are willing to pay much higher prices. Any difference in the par value of the shares and the price paid by the investors is referred to as additional paid-in capital.
It is recorded under the equity section of the balance sheet. All cash proceeds are entered into the cash account on the balance sheet. The corresponding entries to the collected cash are adjusted against the common stock (share capital) and the additional paid-in capital. Together these two items make up the total paid-in or contributed capital of the company.
How to Calculate the Additional Paid-In Capital?
The total paid-in or contributed capital is the capital raised through an IPO. It is the total number of shares subscribed (purchased) by the investors multiplied by the market value. The number of shares multiplied by the par value refers to the share capital. The premium received above the par value of the shares is called additional paid-in capital.
It can be calculated as:
Additional Paid-In Capital = (Issue Price – Par Value) × no. of shares (subscribed by investors)
Working Example
Suppose a company Green Star Co. Goes for an IPO and issues 1 million shares at a par value of $0.50. On the IPO day, the issue price of the shares can be different as investors would be willing to pay a higher amount in anticipation of capital gains.
Suppose the issue price is $ 15 per share. We assume all shares are fully subscribed by the investors. Hence, the total share capital raised through the IPO is $ 15 million.
We can calculate the additional paid-in capital as below.
APIC = (issue price – par value) × no. of shares subscribed by investors
APIC = (15 – 0.50) × 1,000,000 = $ 14,500,000
The company will record $ 500,000 as share capital and $ 14.5 million as additional paid-in capital. The total capital raised through the IPO is $ 15 million called total paid-in capital.
Special Considerations with Additional Paid-In Capital
The book value of the additional paid-in capital is recorded on the IPO day with the issue price. Once it is recorded in the books, it does not change the value. Investors can sell the shares in the stock market at appreciated prices. However, that does not change the APIC values on the company books.
If the company issues new shares, any premium collected will increase the APIC amount. Similarly, if the company retires any stocks permanently, it will reduce the APIC value.
The market value of shares changes continuously. However, the market value does not affect the book values of the stocks. Hence, the company’s APIC does not change with any price movements. It only reflects changes when the company issues or retires stocks. For instance, a company may buy back shares and then retire these stocks permanently. Similarly, any new shares issues such as preferred shares, bonus shares, or compensation shares increase the APIC value.
Pros and Cons of Additional Paid-In Capital
It is an important component of the owner’s equity. It forms the larger portion of the total paid-in or contributed capital. Hence, it offers several benefits to the company and shareholders.
Pros of Additional Paid-In Capital are:
- It provides a substantial source of equity for the company.
- It does not need to be repaid to investors, unlike debt financing.
- The company has no legal obligations to pay returns on investment in the form of dividends.
- The company is free to utilize the capital for various purposes.
- In the case of default, the shareholders cannot claim the lien unless all other debts are settled.
Cons of Additional Paid-In Capital are:
- It is a form of equity; hence it increases the total cost of capital.
- Issuing new shares does not guarantee that all shares would be subscribed.
- Investors cannot always make profits with their investments through share subscriptions.
Conclusion
Additional paid-in capital is the difference between the par value of the shares and the issue price. It is an important part of the contributed capital and the owner’s equity. It is an easier option for any company to raise capital.
